The sweet spot — that's what property investors are looking for

James Kellow, director of New Zealand Mortgages and Securities. Photo / Supplied

With interest rates likely to go lower, investors are now in search for a higher yield on their funds.

Kiwi investors love property with the medium- to long-term lease income profile. As well as growth, they get 'bricks and mortar' security.

Reserve Bank Governor Adrian Orr is correct when he says the likes of Baby Boomers need to start investing in yielding assets.

Their investment can be via direct property or buying a share in a syndicate of listed property trust. Either way with bank deposits rates low, there is currently strong demand by investors.

However, for a vendor to be convinced to sell, the property needs to be at a low yield. It's about finding that sweet spot, where the yield is low enough to encourage the owner to sell, but high enough to secure a buyer.

Regardless, commercial property buildings will increase in value because yield expectations are falling. Whereas previously an investor may have wanted a 5 per cent return, they now may accept 4 per cent. This is a 20 per cent increase in property asset value, assuming rental stays the same.

In this environment, property owners will tend to hold on to commercial assets, but because returns are still higher than bank deposit rates others will be keen to invest. So, the outlook for commercial property owners is good.

Business confidence is subdued so there is probably limited scope for any real rental growth in the short to medium term. However, this will be offset by yield compression on capital values.

So for well-located properties the outlook is good. For vacant properties in fringe locations the outlook will continue to be relatively poor.

Investors in commercial assets need to ensure properties are up to fire and seismic standards. What's more, they need to factor in that tenants may require flexibility as their businesses expand or contract.

Those investing outside of prime locations, need to also be aware that there will probably be limited rental growth.

Adding to the surplus demand and price increases is the fact that there are few quality commercial properties for sale.

The office category is strong in the main centres, with seemingly a shortage in Auckland perhaps intensified by recent apartment conversions, reducing office stock. Wellington has also experienced this.

Good commercial buildings in downtown Auckland remain strong. This may surprise many, given much of Auckland's housing market is going sideways. However, in the central city desirable office stock is limited, overall vacancy rates remain low, and rents are solid.

Many of the businesses today looking for new office space see it through a very international lens. They have international property managers making decisions overseas based on international specifications and hence they demand international-grade buildings.

As well as all the technology and environmental requirements, they want large floor plates for connectivity and hot desking, mixed-use spaces, you name it. But the challenge remains that much of the city's existing office stock can't provide anything like that.

Industrial is sound with warehousing a growth sector assisted by online shopping and demand for distribution centres. Retail property is relatively weak, except speciality retail, food and beverage, and sectors that are protected from online sales.

Overall, yielding commercial assets continue to enjoy good growth. There's no evidence that it will change in the foreseeable future.

In general, good commercial properties in New Zealand are only going to increase in value, with their capitalisation rates now tracking down below 5 per cent.

• James Kellow is the director of New Zealand Mortgages and Securities.